The hedge fund industry makes early forays into China

The much lauded opening of China to hedge funds took a big step forward this month with the news of the launch of Winton Capital Asia's fund with Lyxor and its joint venture partner Fortune in mainland China. Targeting sophisticated investors, including institutions and high net worth individuals, this is the first CTA in China.

Other steps forward this month included the launch of not just one but two hedge fund associations in the country, The Hedge Fund Association's Shanghai chapter, and the Shanghai Hedge Fund Association (SHFA). There was also news that AIMA Hong Kong is actively involved with establishing a Chinese presence. (See interview with AIMA Hong Kong chairman, Philip Tye).

The SHFA immediately launched an offer of creating strategic partnerships with foreign firms interested in offering hedge funds in mainland China, while the Shanghai chapter of the HFA hosted a symposium on hedge funds in China at the Cheung Kong Graduate School of Business in Beijing, and attended by some 40 people. The latter event is reported on in A view from Beijing from Adam Steinberg in this issue of Asian Pacific Intelligence.

Regular readers of Opalesque were alerted to the potential of China entering the hedge fund sector by London Roundtable participant, Laurie Pinto, chief executive officer of North Shore Blue Oak, who spoke on the opportunities that exist but was careful to emphasise that the developing investment market there is new and very slow to adapt. "The first mutual funds were started in 1998. The first licenses issued and money put into QDI and QFI was in 2004" Pinto said at the time.

Pinto listed the three Chinese sovereign wealth funds: the domestic CIC, and the CIC number two which invests internationally; the SAFE, the State Administration of Foreign Exchange which has about $3 trillion of assets and the NSSF, the National State Securities Fund - China's equivalent of CalPERS which has about $500bn to invest and is expected to double over the next four years, and is just beginning to invest in foreign hedge fund of funds.

In an interview with Asia Pacific Intelligence, Pinto, whose firm is based in London and Beijing, said: "It's a country with a population the size of Europe that eight years ago had no structured savings market at all. It's all very new." Pinto expects any new rules which may open the market up to come next Spring at the earliest. "The hedge fund industry will develop of course" he says, "but the biggest challenge is educating the regulators and even then the market will develop in a very different way from how the west has."

Chinese mutual funds are allowed to hold 90% in cash, which makes out performance in a bear market relatively easy and selective shorting was only allowed a year and a half ago, which partly negates the advantages that hedge funds can offer investors. However, there is an appetite for investment and there is certainly a great deal of money.

Despite a recent cooling down, signalled by a June interest rate cut of 25 bps - the first since December 2008 ¢â‚¬â€œ‚ ‚ the Chinese economy has famously seen astonishing growth over recent years with its GDP rising from almost $357bn in 1990 to $1.19tln in 2000, and now standing at around $7.2tln.

The Chinese economy is widely believed to be cushioned by its controlled population growth which is expected to peak at 1.4 billion people by 2025, due to its one child policy according to a recent note from Chong How Ong, the Japan-based portfolio manager of Reech AiM Group which was also reported in Opalesque.

The population might peak, but as Pinto explained at the London Roundtable, they will mostly be living in the cities, with 500 million people moving to the cities, earning money and looking for something to do with it. It is extremely early days to hazard a guess at how much money might flow into foreign hedge funds but Chinese investors are currently investing an estimated $50bn a quarter, despite the fact that, discouragingly, the Shanghai Composite Index is 60% down since its 2008 high.

Many of the current restrictions on investment in or out of China at the moment lie with the currency issues. Paola Subacchi and Helena Huang addressed the current state of liquidity and what they called the connecting dots of China's renminbi strategy in their September paper for Chatham House, the London international affairs institution. They found that London, Hong Kong and Singapore are complementary and essential to China's RMB strategy.

Certainly some firms have achieved investment returns from exposure to the Chinese currency and bonds. The Stratton St Renminbi Bond Fund, with $160m under management, is showing a return of 16.68% to August 2012 and has been running since 2008 when it returned 5.59%; 2009 it saw 11.96%; 2010, 15.33% and 2011, 9.74%. Nigel Johnson from Stratton St explains: "We took a view that the renminbi onshore is undervalued".

The managers point out parallels with Japan which saw substantial economic growth from 1950 to 1990 with the yen appreciating by over 250% against the dollar. Investments are made through non-deliverable forward contracts. Stratton Street Capital fixed income managers believes the renminbi could double in value over a decade if growth were to continue and the exchange rate allowed to float freely.

Hedge funds investing in Greater China have not faired so well. As reported in Opalesque, China's decision to allow foreign hedge funds to set up operations into the country seemed to be paying off in the popularity stakes, as latest data from Eurekahedge showed an increase of investor allocations to Greater China-focused hedge funds despite failing to provide profits.

In a report, AsianInvestor.net said that Greater China-focused strategies now account for 13.5% of the $125.5bn in Asian hedge fund assets, up from 4.4% in 2006 and cited Eurekahedge's data that China has been attracting hedge funds over the past several years.

However, the inflows are not being rewarded with the desired returns as Greater China hedge funds lost an average of -13.05% last year.

Another hedge fund data tracker Hennessee reported that investors are expecting a possible hard landing in China as key economic indicators suggested that a more significant slowdown than previously anticipated.

"Managers suffered losses in China growth bets as the markets declined. Emerging markets were negative as the MSCI Emerging Markets Index fell -0.54% (+3.38% YTD), mostly due to losses in China and Latin America," Hennessee said in its latest market report.

Commenting on the performance of these funds, HSBO's Pinto points out that the Chinese sovereign wealth funds have the structural edge on domestic equity performance as the Chinese regulators organise the order in which companies can achieve an IPO, the usual exit route for a private equity investment. Inevitably the local investors win out over the foreigners and it seems unlikely that this will change in the short term.

In further developments, Opalesque also reported in late August, that the Shanghai Stock Exchange announced plans to allow so-called "sunshine" private trust funds to list on the exchange under certain conditions, in a move to further boost the bourse away from retail investors. Sunshine private trust funds, also known as the prototype for hedge funds but more transparent, might be allowed to list with the Shanghai Stock Exchange and sell their products and services after meeting some conditions.

This article was published in Opalesque's Asia Pacific Intelligence our monthly research update on alternative investments in the Asia-Pacific region.